Is Near Enough To The Bottom Good Enough?

Sydney Morning Herald

Friday December 19, 2008

Simon Hoyle

Simon Hoyle asks an industry fund manager why he has decided to go back into the market - for the long haul.

About three months ago the Retail Employees Superannuation Trust (REST), an industry super fund, decided it was time to start investing some of the cash it had stockpiled the previous year. The fund doesn't have a crystal ball to show when it's safe to go back into the market. And no one rang a bell to tell REST the market had bottomed.

But what REST does have, says its chief executive, Damian Hill, is an investment philosophy that leads it to sell out of markets when they rise a long way and buy into markets when they are near bottom.

By taking a three- to five-year view, it does not have to exactly pick the top or the bottom. It merely needs to be close, it says.

And REST believes it's close enough to the bottom now to warrant a cautious return. Having run up a cash balance of about $1.68 billion, the fund is now committing about half that - or $850 million - to investment markets.

If, like REST and other funds, you have been sitting on the sidelines, biding your time and trying to pick your moment, the decisions you must make are similar to those made by the funds.

"Firstly, we are not looking to pick the bottom, nor were we looking to pick the top at any stage," Hill says.

"We don't believe we can pick the bottom or the top; we know of no investor who has made money in the long term out of picking the bottoms and the tops.

"We've started investing back into markets, and not just the equity markets. We only started doing it over the past two to three months, and we initially started more on the overseas equities side of things, and we've done some drip-feeding into the Australian equity market as well.

"But we're seeing a much broader opportunity set than just the equity markets. This sort of [financial] crisis is highlighting a number of investment opportunities over almost all asset classes."

Hill says that while investing now, REST must make "two assessments" about the assets it buys: first, how much cheaper those assets could become; and second, given the range of choices available, which assets are likely to produce the best long-term return, consistent with the fund's approach to minimising investment risks.

"We're certainly not saying that the things we buy may not get more cheap, but over a three- to five-year time frame we think the fundamentals of what we buy indicate that the probability for our members is skewed towards a favourable outcome."

In other words, the trustees of REST believe that we're close enough to the bottom of investment markets that even if the securities the fund buys fall in value in the short term, there's a better-than-even chance that in three to five years' time the fund will be sitting on pretty good investment gains.

The trustees believe they will look back on late 2008 and early 2009 as having been a good time to invest.

Hill says the fund has not rushed into markets, and it has not committed all its money in one go. It is being selective, and it is committing money in small parcels, over a period of months.

By doing this, it is removing what is called "timing risk" - a risk that is created either by committing all one's money in a market that then plunges, or by sitting on the sidelines and trying to decide how to invest while a market rebounds in a relatively short space of time and posts the bulk of its returns for the foreseeable future.

"Generally, we look to get out of booming markets a little early," Hill says. "We may be a little bit too early, but over the long term, that kind of philosophy has given REST members good long-term returns . . . with the lowest volatility among major funds."

Andrew Pease, an investment strategist for Russell Investments, says that "in general, for most investors, trying to time the market is obviously quite hard".

Pease says that even though there is mounting evidence that many investment markets now offer very good value, there are still risks that need to be navigated.

"For most people I think it's a question of their time horizon. If your time horizon is three years, five years, 10 years, then the value opportunities are quite exceptional. Dollar-cost averaging (DCA) and regular [investment] plans are a very good idea.

"For almost all investors, that would be their best strategy."

Dollar-cost averaging is a strategy that involves dividing your capital into a number of smaller parcels, and investing those parcels one at a time, at regular intervals. Data prepared by the Commonwealth Bank for the Herald, and published in late November, revealed that if you had a five-year outlook, it almost didn't matter how many parcels you divided your capital into and the frequency of your investments, you were highly likely to generate a positive return over the five years.

The chief investment officer for CommBank's private client services division, Ron Bewley, said at that time that if you started on any day after April 1, 1986, divided your capital into three parcels and invested them at six-month intervals, then the poorest five-year return you'd have achieved was 25 per cent, even taking into account the turmoil of November.

But investors looking for a clear sign of when to start investing need to be wary of false dawns. "In terms of what I am looking for, what you're seeing is a lot of [good] signs, but the problem is that you've been seeing these for a couple of months now," says Pease.

A good sign, paradoxically, is pessimism. When pessimism peaks, says Pease, the market generally is at or near its bottom. But over the past few months, just when it has seemed that things could not get any worse, they did get worse. It's little wonder confidence is in the doldrums. Sentiment is "a classic contrary indicator", Pease says.

We're probably not yet at the peak of pessimism, and therefore not yet at the bottom of the market, but we won't truly know until after the fact.

What's not in dispute, Pease says, is that the values of some shares represent compelling value right now. Even though the prices may fall further in the short term, Pease believes that if investors aren't buying now, or in the next little while, then come 2010 they'll be kicking themselves wondering why they weren't.

Pease says it comes back to one's time horizon: if you're investing money today that you will not need for five to 10 years, then early 2009 may offer some of the best buying opportunities in a lifetime.

Even though fortune is said to favour the brave, it still takes guts, a good plan and a certain amount of contrariness to wade into a market that is still gripped by fear and uncertainty. For investors, uncertainty equals volatility. When volatility is high, as it is now, it means the outlook is very uncertain. For professional investors, some (though not total) certainty is desirable. But as long as volatility remains as high as it is now, professional investors will remain cautious.

One financial measurement that share investors often use to gauge the value of a share is its price/earnings (PE) ratio. That is, a company's earnings per share (EPS), divided by the share price.

For any company, we know with certainty what its share price is - the "P" - but what is a lot less certain at the moment is a company's earnings - the "E".

David Bryant, head of Australian Unity Investments, says there's no doubt that as the global financial crisis moves from financial markets and through the real economy, company earnings will fall.

But he says it's unlikely that the earnings will fall by as much as necessary to lift PE ratios back to long-term levels - in other words, shares are looking quite cheap, on a PE measure.

However, Bryant says investors need to be selective about what they buy, and to wait for more compelling signals to emerge. He says we've been through the worst of the financial crisis and the economic "crisis" is in the process of playing out. Markets are likely to remain volatile for some time.

"What we've got is a crisis of confidence," Bryant says. Investors should be looking for signals that confidence is improving.

One such indicator might be the unemployment rate. Your view of how severe a recession is often depends on whether or not you lose your job. Bryant says unemployment is expected to rise as the economic situation worsens; confidence may begin to improve once the rate stops climbing, or when it starts to fall.

A falling unemployment rate generally means the economy is growing.

So, "when I know the economy is growing again, that may be a good time to get back in", Bryant says.

"But gross domestic product growth numbers take a long time and they are unreliable."

It's not unheard of for a recession to have been and gone before it is reflected in GDP numbers.

"I'd be looking much more at sentiment; so consumer surveys, surveys of business and unemployment - when that stops going up you can really say with some confidence that things are in better shape."

Bryant says there's no need to try to pick the very bottom; knowing it's very close is enough, provided you can take a long-term view of your investments, and you can stand some short-term volatility.

Balanced funds run by Bryant and his team - funds that invest money across a range of different asset classes - give an insight into how confident they are about the outlook for each asset class.

As things now stand, Australian Unity's capital-stable diversified fund is underweight in cash, given recent significant and marked interest rate reductions, and underweight in international equities. It is slightly overweight in mortgages and overweight in unlisted property. It is neutral in fixed interest and Australian equities. (See table, "Money where their mouth is".)

"By and large we're pretty neutral," Bryant says. "We've never had an aggressive asset allocation [that is, a high allocation to growth assets]. Our growth assets are pretty much line-ball."

© 2008 Sydney Morning Herald

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